About this Author

College chemistry, 1983

The 2002 Model

After 10 years of blogging. . .

Derek Lowe, an Arkansan by birth, got his BA from Hendrix College and his PhD in organic chemistry from Duke before spending time in Germany on a Humboldt Fellowship on his post-doc. He's worked for several major pharmaceutical companies since 1989 on drug discovery projects against schizophrenia, Alzheimer's, diabetes, osteoporosis and other diseases.
To contact Derek email him directly: derekb.lowe@gmail.com
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August 24, 2004

I'll Have the Price They're Having

Posted by Derek

Thanks to Arnold Kling, I found this piece on the economics of the drug industry. It comes from the remarks at a recent industry conference, and it's worth reading (even if it does make an approving reference to Marcia Angell near the end) - an excerpt:

If the prosperous flow of innovations was to be sustained (he said), either the industry would have to find a way to dramatically alter its cost structure, or else "we are going to have to figure out collectively some way across political parties and countries to construct and maintain a structure of global price differentials."
With the promise that changes in the cost structure would be addressed in another meeting later in the fall, attention turned to various schemes for differential pricing.

Berndt skimmed quickly over the traditional argument for differential pricing. Many industries had high fixed costs and relatively low marginal costs, he said -- electricity, telecommunications, software, database services, movies, and so forth.

But none was the same class as pharmaceuticals, where the difference in incremental cost between the first tablet of a new medicine and the second is on the order of $800 million for an average medicine --$800 million to "get the science right" and make certain that the treatment works in some degree, 25 cents to make the second copy, and the third and as many more tablets as can be sold.

Not being an economist, I'd never thought of it in quite that way. It's a familiar illustration of the problem of software piracy, though, or file-sharing of copyrighted work. We don't have as much of a piracy problem in pharmaceuticals (although it's certainly there), since it's harder for a third party to run off further copies of our pills.

The focus on differential pricing is justified. That's what the whole drug reimportation debate comes down to, and it's the corner my industry has painted itself into. This meeting seems to have mostly tried to find ways to maintain the existing system, which is at least better than suddenly yanking it down. That is, it's better for all of us who would be suddenly pitched onto the street, and it's better for our customers, who in a few years might wonder why there haven't been any new drugs to treat their diseases for a while.

But I'll really be interested in the next conference mentioned above. I think that eventually we're going to have to move to a new pricing structure, and I don't know what it's going to look like. The article itself has a suggestion, which I'll address separately - Arnold Kling has a follow-up on it here. Whatever it is, we're going to need some time to get ready for it.

What I'd like to see is the US Gov't passing a law banning ALL differential pricing (with, perhaps, and exception for Africa).

Something straightforward and simple like: if you want to be able to sell your drug anywhere in the US, you can charge different prices for different quantaties (i.e. one price per 1000 grams / pills / cc / whatever, and a different price for 2000), but you must offer everyone in the US the lowest price you offer anyone, anywhere.

On the one hand, this sucks, because it attacks incentives to cut the cost of bringing a drug to market in the US.

On the other, it totally ends the "reimportation" debate, and stops whatever free ride Europe and Canada have been getting from US consumers.

If the US really is the major source of pharma profits, such a law should work.

I'm s bit dubious of the "25 cents to make the second copy" bit. 20 mg is a reasonable amount of active ingredient so 25 cents for 20 mg is about 12.50 a gram. Given what aldrich charges for nonracemic alpha amino alcohols or unnatural amino acids or protected amino acids, I don't see how 12.50 a gram is a reasonable price. No clue what things really cost for super large scale but I'd peg it at closer to 500-1000$ a gram for anything with more than one step, so 10-20 bucks for that second pill (less than 800 million obviously).

Don't forget, a important step in the R&D process is perfecting the means of dependably producing the new substance in quantity. That falls into the $800 million part. In addition to making it available for researchers a big step in investigating a newly discovered substance from some exotic source is the need to synthesize it so that it can be economically viable if it should prove useful as a drug.

I sometimes wonder if the proponents of "reimportation" might actually have a good idea, though not for the reason they think.

Take Canada, for instance. If the US did in fact start massively reimporting drugs from Canada, the Canadian system would be drained of drugs and Canadians wouldn't be able to get them -- because Americans were willing to pay a higher price. Canada could conceivably try to prevent it legally, but NAFTA would be a problem, and in any case it's pretty difficult to prevent.

The government of Canada might ultimately have to raise the price of drugs in Canada, so that they no longer were attractive for Americans to reimport. If they did, the drug companies could reasonably ask for a cut of the increase -- and that, then, would help subsidize the research and might permit the drug companies to lower the price in the US.

Yes, I know some of the links in that logic chain are a little weak, but the larger idea is simply that as long as other nations are trying to free-ride on high American drug prices paying for all the research, then reimportation spoils the game by draining all the artificially-low-priced drugs out of their system.